This article first appeared in Digital Edge, The Edge Malaysia Weekly on June 12, 2023 - June 18, 2023

Southeast Asia has made good progress when it comes to venture capital and private equity funding as the ecosystem has built itself quite nicely. While the region is still behind mature markets like the US and Europe, the momentum is growing, which is a positive sign for the region.

However, the slowdown Southeast Asian economies are experiencing is affecting the relationship between investors and start-ups.

Jeremy Tan, co-founder of Singapore-based venture capital fund management company Tin Men Capital, says the abundance of capital that went into investing in start-ups until recent months has since dried up.

There are a few things happening in the market simultaneously, says Tan, explaining that when the tide recedes, it will be evident that companies have relied solely on cheap capital to grow and are now suffering as there is no clear path to profitability.

“Once the funding stops, the lucky ones still get to raise money but at a reduced valuation. Those that eventually run out of cash will, unfortunately, come to pass. A lot of VCs (venture capitalists) are asking their portfolio companies to prepare for a long winter,” he says.

To circumvent the challenge, Tin Men Capital’s portfolio companies have been encouraged to shift towards a path to profitability because funding will still take place as there is a fair bit of committed capital sitting on the sidelines.

“Research suggests that there is anything between US$350 billion and US$500 billion of dry powder that needs to be deployed because these funds have a fixed time frame to be deployed. These funds need a home,” says Tan.

“I think what’s happening now is that companies that demonstrate good growth as well as positive gross margins are getting funded, and there is a renewed focus on capital efficiency and good business models to be profitable.”

Tin Men Capital invests in companies that are raising Series A funding, specifically companies that have a product that has achieved product-market fit. In other words, the product has to meet customers’ needs.

The firm focuses on investing in enterprise tech companies in the business-to-business (B2B) space as the gross margins are positive — a segment that a lot of investors are looking into because of its profitability, especially since capital is scarce.

However, Tan stresses that fundraising is not — and should not be — the end game for companies and a start-up’s success should not be tied to whether it achieves unicorn status.

He puts forward this analogy: If Company A is sold or takes the initial public offering (IPO) route for US$500 million and has raised US$50 million through its lifetime, on a blended basis, it is providing 10 times the return. Meanwhile, Company B, which achieved unicorn status, may have raised US$200 million through its lifetime, which means that the blended returns are five times. From a shareholder standpoint, Company A has done better through the lens of returns, even though it is not a unicorn.

“But then again, if we take a step back, this example is still quite flawed because there are many facets to a good company such as its culture and impact. Even from this narrow example, you can see that being a unicorn is not the be-all and end-all,” says Tan.

“Unicorns are quite rare and hard to find. That’s why we veer away from depending on building a unicorn. There are many good companies out there that never achieve unicorn status that are efficient with their capital and provide good service, and they deserve the same attention.”

The demand for returns is greater today because of higher interest rates and a turbulent economic landscape. And because of that, the pace of deployment has come down. Tan says this domino effect will impact everyone in the ecosystem, whether it is a deep tech company with a long gestation period or a software-as-a-service company that is already in the market.

The impact, however, varies depending on the stage a company is in. Growth-stage companies are the most impacted as they would have seen a lot of capital inflow and thus, ramped up valuations. The correction that is happening now is much more pronounced, says Tan.

“Investors are waiting for the dust to settle before doing deals because they don’t know how to price the deal. If you’re a late-stage investor, you’re also thinking about whether you can exit in the public markets for what you’ve priced to sell.

“For companies that have a longer gestation period, like tech companies that carry out a lot of R&D and have less visibility to profitability, they will be impacted too because of the focus on profitability. But there might be different funds that are focused exclusively on this type of start-up.”

Tan advises companies to have a sense of mission and to ensure that their product actually meets the needs of customers before trying to achieve product-market fit. This is to avoid investing too much in the scaling and selling of the product in the event it is something that people do not want.

“If you end up selling something that people may not want, you’ll end up burning cash. And usually, if you’re burning cash in the early stage, it is an indication that you’re not efficient financially,” he says.

“A sense of mission is also important. And from a fundraising standpoint, raise whatever you need and don’t chase valuation. Because if you do that, you will be setting the bar much higher.”

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